[Federal Register Volume 87, Number 177 (Wednesday, September 14, 2022)]
[Notices]
[Pages 56477-56480]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-19813]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-95707; File No. SR-CBOE-2022-036]


Self-Regulatory Organizations; Cboe Exchange, Inc.; Order 
Approving a Proposed Rule Change To Amend Cboe Rule 5.6 and Cboe Rule 
5.33 To Allow Delta-Adjusted at Close Orders To Be Submitted in FLEX 
Equity Options

September 8, 2022.

I. Introduction

    On July 8, 2022, Cboe Exchange, Inc. (``Cboe'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change to allow the Delta-Adjusted at Close (``DAC'') Order Instruction 
to be submitted in FLEX equity options on the Exchange. The proposed 
rule change was published for comment in the Federal Register on July 
27, 2022.\3\ The Commission has received no comment letters on the 
proposal. This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 95344 (July 21, 
2022), 87 FR 45138 (``Notice'').
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II. Description of the Proposed Rule Change

    The Exchange proposes to amend Cboe Rule 5.6 (for simple DAC 
orders) and Cboe Rule 5.33 (for complex DAC orders) to allow DAC orders 
to be submitted in any FLEX option, including equity options, except 
that a simple DAC order submitted in a single stock equity option may 
not be submitted until 45 minutes prior to the market close and may not 
be submitted on its expiration day.\4\
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    \4\ The Exchange notes that references to equity options and 
equity securities within this proposed rule change refers to options 
on securities that are not exchange-traded products (``ETPs'') and 
equity securities that are not ETPs (i.e., single stock securities), 
respectively. Under this proposal, DAC orders will continue to be 
available only for FLEX options. For a more detailed description of 
the proposed rule change, see Notice. Id.
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    A DAC order is an order for which the System \5\ delta-adjusts its 
execution price after the market close.\6\ Currently,

[[Page 56478]]

the DAC order instruction is available for simple \7\ and complex \8\ 
FLEX orders in options on ETPs and indexes for execution in a FLEX 
electronic auction or open outcry auction on the Exchange's trading 
floor pursuant to Rule 5.72.\9\ A DAC order allows Users to incorporate 
into their options pricing the closing price or value of the underlying 
on the transaction date based on how much that price or value changed 
during the trading day. After the close of trading and upon receipt of 
the official closing price or value for the underlying ETP or index 
from the primary listing exchange or index provider, as applicable, the 
System adjusts the original execution price of the order based on a 
pre-determined delta value applied to the change in the underlying 
reference price between the time of execution and the market close.\10\
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    \5\ The term ``System'' means the Exchange's hybrid trading 
platform that integrates electronic and open outcry trading of 
option contracts on the Exchange, and includes any connectivity to 
the foregoing trading platform that is administered by or on behalf 
of the Exchange, such as a communications hub. See Cboe Rule 1.1.
    \6\ See Cboe Rule 5.6(c) and Cboe Rule 5.33(b)(5). See also 
Securities Exchange Act Release No. 90319 (November 3, 2020), 85 FR 
71361 (November 9, 2020) (SR-CBOE-2020-014) (``DAC Approval 
Order'').
    \7\ See Cboe Rule 5.6(c).
    \8\ The DAC order instruction would apply to each leg of a 
complex order. See Cboe Rule 5.33(b)(5).
    \9\ In addition, pursuant to the definition of a DAC order under 
Cboe Rule 5.6(c) and Cboe Rule 5.33(b)(5), a DAC order submitted for 
execution in open outcry may only have a Time-in-Force of Day. A 
User may not designate a DAC order as All Sessions.
    \10\ See Notice, supra note 3, at 45138, for a more detailed 
description of a DAC order.
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    The Exchange states that DAC orders are designed to allow investors 
to incorporate any upside market moves that may occur following 
execution of the order up to the market close while limiting downside 
risk. The Exchange states that significant numbers of market 
participants interact in the equity markets near the market close, 
which may substantially impact the price of an underlying equity 
security at the market close. For example, the Exchange understands 
that market makers and other liquidity providers seek to balance their 
books before the market close and contribute to increased price 
discovery surrounding the market close. The Exchange also understands 
it is common for other market participants to seek to offset intraday 
positions and mitigate exposure risks based on their predictions of the 
closing underlying prices. The Exchange notes that this substantial 
activity near the market close may create wider spreads and increased 
price volatility, which may attract further trading activity from those 
participants seeking arbitrage opportunities and further drive prices. 
The significant liquidity and price/value movements in securities, 
including equity securities, that can occur near the market close may 
cause option closing and settlement prices to deviate significantly 
from option execution prices earlier that trading day. As such, the 
Exchange wishes to provide its investors with the same opportunities to 
incorporate any upside market moves that may occur following execution 
of the order up to the market close while limiting downside risk in 
their equity options trading as currently provided for their ETP and 
index options trading by making DAC orders available in equity options.
    The Exchange states that DAC orders are intended to benefit 
investors that participate in defined-outcome strategies,\11\ which, at 
the time the DAC order was adopted, existed only for indexes and ETPs. 
Particularly, DAC orders allow such funds to employ certain FLEX 
options strategies that enable their investors to mitigate risk at the 
market close while also participating in beneficial market moves at the 
close.\12\ The Exchange states that it has recently been made aware 
that defined-outcome investment strategies are being created to provide 
exposure to individual equity securities and as a result has received 
growing customer demand to make DAC orders available in equity options. 
The Exchange understands that, like defined-outcome strategies for ETPs 
and indexes, such funds for single stock equity securities would seek 
to use multi-leg strategy orders when seeding their funds,\13\ and, 
like for any defined-outcome strategy, the goal of the strategies used 
by defined-outcome funds for single stock securities would be to price 
the execution of multi-leg strategy orders at the close of the 
underlying. Also, the Exchange understands that funds for multiple 
single stock equity securities would seek to use single-leg (i.e., 
simple) orders to create a strategy when seeding their funds.\14\ 
However, there is operational execution risk in attempting to fill an 
order near the close to capture the underlying closing price. A DAC 
complex order currently allows the User to execute a strategy order in 
connection with a fund for an ETP or an index prior to the close and 
have its price adjusted at the close. The proposed rule change would 
allow a User to execute strategy orders in connection with seeding a 
fund for an equity security in the same manner.\15\ Like DAC complex 
orders for strategy orders in ETP and index options currently, DAC 
orders in equity options, either simple or complex depending on the 
structure of the fund, would allow the strategy order or orders to be 
executed at a time before the close, eliminating the execution risk, 
while realizing the objective of pricing based on the exact underlying 
close for those strategies that require pricing at the close or a 
defined amount of market exposure through the close. The Exchange 
states that the proposed rule change would allow Users to participate 
in the same benefits--eliminating execution risk while realizing 
objective pricing--for their strategies in equity options as they 
currently may for their strategies in ETP and index options.
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    \11\ Including defined-outcome ETFs, other managed funds, unit 
investment trusts, index funds, structured annuities, and other such 
funds or instruments that are indexed managed funds.
    \12\ See DAC Approval Order, supra note 6.
    \13\ The Exchange understands that, like defined-outcome ETFs 
for ETPs and indexes, issuers of defined-outcome ETFs for equity 
securities would not buy stocks directly, but instead, use options 
contracts to deliver the price gain or loss of the underlying over 
the course of a year, up to a preset cap.
    \14\ The Exchange notes that funds for multiple single stock 
equity securities would seek to use simple orders across multiple 
single stock equity options when seeding their funds as multi-leg, 
multi-class strategies in single stock options are not available for 
trading on the Exchange.
    \15\ The Exchange states that because multi-leg strategies 
themselves may have delta offsets, the User is hedged, meaning that 
the User may realize a negative movement versus the initial 
execution on some legs, which is offset by a positive move in other 
legs. The Exchange notes that the strategies may or may not define 
an exact delta offset (``delta neutrality'' occurs where the 
strategy defines an exact delta offset). Given the delta neutral 
nature of an order with exact offset, a User is indifferent to any 
movement in the underlying from the time of execution to the close. 
Whether a User defines an exact delta offset, a User anticipates a 
given amount of market exposure, either partial or none, depending 
on the strategy and combinations of buy/sell, call/put and quantity. 
See Notice, supra note 3, at 45139 n.10.
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    Consistent with the foregoing rationale, the Exchange proposes to 
make the DAC order instruction available for orders submitted in any 
FLEX option, including equity options. In particular, the proposed rule 
change amends the definition of a DAC order (simple and complex)\10\ to 
allow for DAC orders to be submitted in equity options by removing the 
restriction that a DAC order may only be submitted in options on ETPs 
and indexes.\16\ In addition, the amended definition of a simple DAC 
order under Cboe Rule 5.6(c) provides that a DAC order in a single 
stock equity option may not be submitted (1) until 45 minutes prior to 
the market close and (2) on its expiration day.
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    \16\ The amended definition of a simple DAC order under Cboe 
Rule 5.6(c) also provides that a DAC order may only be submitted for 
execution in a FLEX electronic auction or open outcry auction on the 
Exchange's trading floor pursuant to Cboe Rule 5.72.
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    The Exchange proposes to limit the use of the DAC orders in equity 
options until 45 minutes prior to the market close and on its 
expiration day to

[[Page 56479]]

mitigate manipulation concerns. Specifically, the Exchanges notes that 
single stock equity securities tend to be less liquid and experience 
greater price sensitivity and larger market moves than indexes or ETPs 
and increased trading volume generally makes it more difficult to 
manipulate the price of a security. The Exchange notes that on 
expiration day in particular, underlying equity securities may 
experience more price sensitivity and may be more susceptible to 
manipulation than on non-expiration days.\17\ Similarly, the Exchanges 
proposes that simple DAC orders in single stock options be required to 
be submitted no earlier than 45 minutes before the market close in 
order to reduce the amount of time that the underlying price could 
potentially move in order to mitigate the risk upon price adjustment at 
close to holders of DAC options.\18\
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    \17\ Options holders on expiration day, whether their positions 
were taken via a DAC execution, are subject to the risk of price 
swings in the underlying prior to the final close; however, options 
holders of positions taken via a DAC execution may potentially be 
more susceptible to such risk given the price adjustment at the 
close. For example, if a market participant executes a DAC order to 
buy calls on expiration day and a large price swing follows, in 
that, the underlying price is pushed significantly higher before the 
close, the DAC option holder would be forced to pay a much higher 
premium upon adjustment, and ultimately expiration. Therefore, in 
order to mitigate the potential risk associated with expiration day 
price swings, which may potentially expose DAC order users the gamma 
effect of options as they become more sensitive to underlying price 
changes as they approach expiration, particularly in options 
overlying less liquid securities, the proposed rule change restricts 
trading (regardless of opening or closing) in simple DAC orders in 
single stock options on expiration day. See Notice, supra note 3, at 
45139.
    \18\ The Exchange notes that the same potential incentive to 
``push'' the price of the underlying on expiration day in connection 
with the exercise price of an option is greatly diminished for 
multi-leg orders given that parties to multi-leg transactions are 
focused on the spread or ratio between the transaction prices for 
each of the legs (i.e., the net price of the entire complex trade). 
See id.
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    Under this proposal, the current rules regarding the entry, 
execution and processing of DAC orders submitted in ETP and index 
options would apply to DAC orders submitted in equity options.\19\ In 
addition, unadjusted and adjusted DAC trade information for DAC orders 
in equity options would be sent to the transacting parties, Options 
Clearing Corporation (``OCC'') and Options Price Reporting Agency 
(``OPRA'') in the same manner as such trade information for DAC orders 
in ETP and index options is sent today.
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    \19\ See Cboe Rule 5.6(c) (definition of simple DAC order), Cboe 
Rule 5.33(b)(5) (definition of complex DAC order), and Rule 
5.34(c)(11) (DAC order reasonability check). The Exchange notes too 
that all DAC orders, currently and as proposed, are entered, priced, 
prioritized, allocated and execute as any other FLEX Order would 
when submitted into any FLEX electronic or open outcry auction and, 
like any FLEX Order, a FLEX DAC order may only be submitted into 
FLEX Options series eligible for trading pursuant to the FLEX Rules.
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    Finally, Cboe represents that it has analyzed its capacity and that 
it believes that OPRA and it have the necessary systems capacity to 
handle any additional order traffic, and the associated restatements, 
that may result from the submission of DAC orders in equity options and 
represents that it continues to have an adequate surveillance program 
in place to monitor orders with DAC pricing, including such orders in 
equity options. The Exchange also represents that it has not observed 
any impact on pricing or price discovery at or near the market close as 
a result of DAC orders submitted in ETP and index options and does not 
believe that making DAC orders available in equity options will have 
any impact on pricing or price discovery at or near the market close.

III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Exchange Act and the 
rules and regulations thereunder applicable to a national securities 
exchange.\20\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Exchange Act,\21\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to prevent fraudulent and manipulative 
acts and practices, promote just and equitable principles of trade, to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system and, in general, to protect 
investors and the public interest, and not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
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    \20\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \21\ 15 U.S.C. 78f(b)(5).
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    The Exchange proposes to expand the DAC order instruction, 
currently available for FLEX options on ETPs and indexes, to any FLEX 
option, including equity options. As with existing DAC orders for ETPs 
and indexes, DAC orders on single stock equity options will be 
available for use with both simple and complex orders in electronic or 
open outcry auctions. In addition, simple DAC orders submitted in a 
single stock equity option may not be submitted until 45 minutes prior 
to the market close and may not be submitted on its expiration day. In 
all other material respects, DAC orders in single equity options will 
operate the same way as DAC orders on ETPs and indexes. The Exchange 
states that the same rules regarding the entry, execution and 
processing of DAC orders submitted in ETP and index options will apply 
to DAC orders submitted in equity options.\22\ The Exchange states that 
the DAC order instruction will allow market participants to incorporate 
into the pricing of their FLEX options the closing price of the 
underlying on the transaction date, based on the amount in which the 
price or value of the underlying changes intraday.\23\ The Exchange 
also states that the DAC order will be useful to investors that engage 
in defined-outcome strategies and that certain defined-outcome 
strategies are being created to provide exposure to individual equity 
securities.\24\
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    \22\ See Notice, supra note 3, at 45139-45140.
    \23\ See id. at 45140.
    \24\ See id.
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    The Commission believes that the proposed rule change is reasonably 
designed to allow market participants to more effectively incorporate 
the closing price of the underlying into the execution price of the 
FLEX equity option, which should facilitate the ability of market 
participants to execute certain investment strategies. Specifically, as 
the Exchange notes, the DAC order instruction would allow FLEX equity 
option orders to be executed at a time before the close, eliminating 
execution risk near the market close and thereby realizing the 
objective of pricing based on the exact underlying closing prices.
    The Commission notes that all DAC orders, including DAC orders in 
single stock equity options, will be entered and processed pursuant to 
the existing FLEX rules like any other order that is submitted into a 
FLEX electronic or open outcry auction.\25\ The Commission believes 
that certain market participants already use the DAC order instruction 
for options on ETPs and indexes to achieve certain investment 
strategies, and that market participants should have familiarity with 
the use of the DAC order instruction on single stock equity options for 
similar purposes.
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    \25\ See Cboe Rule 5.72(d).
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    Additionally, the Commission believes that the proposed 
restrictions in connection with the submission of simple DAC orders in 
equity options are designed to prevent fraudulent and manipulative acts 
and practices and protect investors by mitigating the potential risk 
associated with expiration day price swings, which may potentially

[[Page 56480]]

expose DAC order users to the gamma effect of options as they become 
more sensitive to underlying price changes as such options approach 
expiration, and reducing the amount of time during which the underlying 
price could potentially move. As described in the Notice,\26\ single 
stock securities may experience greater price sensitivity and may 
experience larger price swings than compared to indexes and ETPs, and 
DAC options holders particularly may potentially be subject to a 
greater risk of paying much higher premiums given the price adjustment 
at close. The Commission believes the proposed restrictions are 
designed to minimize any potential incentive to attempt to manipulate 
the equities that may underlie a DAC order, particularly those 
securities that may experience relatively lower volume, and are 
designed to mitigate potential risk to holders of DAC options on single 
stock securities.
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    \26\ See Notice, supra note 3, at 45139.
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    Finally, the Commission notes that the Exchange represents that: 
(1) it believes the Exchange and OPRA have the necessary systems 
capacity to handle any additional order traffic, and the associated 
restatements, that may result from the submission of DAC orders in 
equity options; (2) it continues to have an adequate surveillance 
program in place to monitor orders with DAC pricing, including such 
orders in equity options; (3) it intends to further enhance its 
surveillances to, among other things, monitor for certain changes in 
delta and stock price between an original order and the final terms of 
execution and to generally monitor activity in the underlying 
potentially related to DAC trades; (4) it has not observed any impact 
on pricing or price discovery at or near the market close as a result 
of DAC orders submitted in ETP and index options and does not believe 
that making DAC orders available in equity options will have any impact 
on pricing or price discovery at or near the market close; and (5) it 
has not identified an impact on pricing or price discovery at or near 
the close as a result of exercise prices for FLEX Equity Options series 
formatted as a percentage of the closing value of the underlying 
security, which is similar to a DAC order instruction and currently 
permitted on the Exchange.
    Accordingly, for the foregoing reasons, the Commission believes 
that this proposed rule change is consistent with the Exchange Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\27\ that the proposed rule change (SR-CBOE-2022-036) be, 
and hereby is, approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-19813 Filed 9-13-22; 8:45 am]
BILLING CODE 8011-01-P